Sensex, Nifty at all time highs: 5 warning signs

The sharp rally in the markets has taken everyone by surprise. Post the easing of tension in Ukraine, markets across the globe have moved higher. Indian markets too joined the bandwagon with a trumpet. After touching new lifetime highs on Thursday, both the indices traded 1.5 per cent higher.

Warren Buffett has a quote for times like these when markets are defying gravity and logic. Buffett says that it is better to be fearful when everyone is greedy and greedy when everyone is fearful.

The current rise in the indices has signs of euphoria, but we are not yet in the bubble zone. This is because valuations are still not at the upper end of price to earning band, let alone being in the bubble valuation zone.

The current rally is being called a ‘Hope rally’, in hope that Narendra Modi led BJP with its agenda for development will come to power. This is also reflected in the move in the capital goods and banking sectors which is discounting such growth.

However, unlike most of the earlier rallies, the present one is restricted to a few sectors. Importantly, retail investors seem to have missed the bus. Small and mid-cap indices are at least 40 per cent away from their all-time high levels. Money flow into mutual funds also does not indicate retail participation, nor does volume in most of the broking houses. The sharp rise will suck in new investors who will be left high and dry when the tide changes.

Further, open interests in the Nifty futures market continues to remain high indicating increased speculative interest in the market. This can lead to extreme movement in case of adverse news flow.

Like every sharp rally, one needs to be wary of such moves. Here are five parameters to look out for when to exit. One need not wait for the market to fall to exit, but even a consolidation can be a good zone to exit.

1. The only reason that the market is moving higher is on account of foreign investors pumping in money. In order to check foreign investor flow, one needs to keep a tab on the value of rupee. Presently rupee has breached the 61 mark but any signs of weakening will have a cascading effect on the market.

2. FII investment is largely concentrated in 75 stocks. Some of them have already reached the maximum permissible limit an FII can invest. Consolidation of prices in some of these stocks can indicate buying fatigue.

3. Oil and gold prices are good indication of money moving out of equity markets into other asset classes.

4. The newly launched VIX futures in an excellent indicator of panic. Known as the fear index, it rises with rise in expectation of a potential fall in price. Presently VIX is near the lower end of its band, which explains the sharp rise in market. One needs to be vary of the market the moment VIX starts raising its head.

5. Being an event based rally (general elections), one needs to keep their ears on the ground to check for swaying election moods. Any adverse result for the BJP led NDA will change the mood in the markets as foreign investors dislike instability.